20 | FRACTIONAL EXTRA WORDS | David M. Disick
BUSINESS
www.opp.org.uk | JANUARY 2012
Wrapping it all up S
In his third and fi nal keynote article on the ins and outs of fractional fi nancing, American expert and author David Disick looks at probably the trickiest stage of them all – wrapping up the deal and getting the cash in your bank account.
o far, your fi nancing discussions have been proceeding well, and one or more bankers are showing interest in your business plan. You feel ready to plant your shovel in the ground. But the banker’s vault is not yet open. Wrapping up fi nancing can be challenging, especially if you don’t know what deal-terms banks usually expect and which items may be negotiable and which may not be. So, since “forewarned is forearmed,” here is some current information on deal parameters that you may fi nd useful. Getting into the vault - negotiating your deal successfully: A. Sizing up your fi nancing proposal. Each large fi nancing institution usually
has its own “radar screen.” This is the minimum deal size necessary to attract its attention. A minimum amount for developer fi nancing is a request of USD $25 million. For consumer fi nancing, it is a projected loan volume of USD $50 million over a two-year period. Larger deals are generally preferred. Smaller deals, however, may not
necessarily be ruled out. Funding would be based on the strength of the deals, the expertise and track record of the developer and his team and the likelihood of additional deals from the same developer.
B. Recommended minimum return
on development equity: A projected return on development
equity of at least a 25% IRR is advisable. This can be subject to deal-specifi c considerations, such as, the trade-off between overall return and timing of return and the institution’s goals for each. C. Profi t splits and the “Waterfall” of distributions. The “waterfall” of distributions is
the sequencing of distributions to the capital source and to the developer. There are various ways the waterfall may be structured. These include: 1) 100% to the institution until repayment of capital; 2) Distributions refl ecting the ratio of developer investment to institutional investment; 3) Overall profi t potential for the institution; and 4) The institution’s evaluation of the project’s strengths and risks. The capital source normally receives
the larger return and receives it fi rst. Splits usually depend on items such as: 1) Ratio of developer investment to that of the capital source; 2) The project’s sales performance and actual results relative to projections; and your capital source’s investment criteria. D. Expectations for the timing of
return of / on equity. A workable general rule for a return
of equity is 2- 3 years from the date of funding. A good general rule for return on
equity is 3 - 5 years from investment date. E. Competition for investment
capital. As a developer, it is important that
you be aware of your competition for real estate investment capital and know how to persuade lenders that investing in your development is a more prudent choice. Many fi nancing sources today are focusing on buying “distressed” properties - secondary properties in secondary areas that are deeply discounted - with the hope of an eventual economic turnaround. This is obviously not the profi le for typical high-end fractional properties. Yet, the demonstrable fact is that buying
“Document the profi t opportunity in the fractional vacation home industry and in your development”
luxury properties favourably (though not “distressed”) for fractionalising can produce comparable or greater profi ts with more speed and less risk than buying “distress.” It is suggested that you show this fact with mathematical models. F. Return on institutional debt … if applicable This will be determined by reference to the base rate in your market area plus additional points or a percentage interest in profi t to refl ect the perception of increased risk. G. Consumer fi nancing If your lender offers consumer
Bank vaults | can be opened if you know how to play by the fi nance game’s rules
fi nancing, you may encounter the following issues: 1. Request for developer guarantee of delinquent loans. This can take two forms: a) A delinquent note is defi ned as 60 days overdue, with the developer having another 30 days to generate a sale of the fractional interest before the guarantee is called upon; b) The second, less appealing, is recourse to the developer for a defi ned period of one to two years. I suggest that you do not resist
David Disick is president of The Fractional
Consultant.com which helps developers in the U.S. and abroad secure fractional fi nancing
www.TheFractionalConsultant.com
these requests because they are almost always included and, by defi nition, you will be selling to qualifi ed buyers. Thus, your exposure will likely not be high. 2. A “holdback” reserve. You
may also anticipate a request that you establish a “holdback” reserve; namely, an escrow fund of 3% to 5% of each sale for a period to be determined, generally one to two years. Here, it is suggested you resist this request, since the developer guarantee should suffi ce.
3. Lender remedies on default. It is
suggested you show your lender that it has the same remedies on default by an individual fractional owner as it would have with whole ownership. It is essential to point out to the lender that its right to foreclose on a defaulting borrower will not be prevented or impaired because there are other co- owners of the residential unit. 4. Past performance of fractional
mortgage funding. It is advisable to document the excellent past performance of fractional mortgage funding and show that the current lack of such funding results from general economic conditions unrelated to the quality of these mortgages. The bottom line is that fractional
fi nancing is available. You will maximise your chances of securing your fi nancing, if you follow these three guidelines: 1. Present and document the signifi cant
profi t opportunity in the fractional vacation home industry and in your development. 2. Prepare a business plan that includes all the information lenders need to evaluate the fi nancial prospects of your development. 3. Know the fi nancial issues to expect and how to negotiate them.
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